Making fiscal decentralisation work

02/12/2013 - Hundreds of thousands of elected sub-national governments worldwide provide services and levy taxes on residents and companies. The trend towards decentralisation over the past 20 years has increased their capacity to affect the economic and fiscal course of their country, while the global economic crisis has created new challenges for balancing budgets at all levels of government.

The report will be presented during the 3-5 December meeting of the International Tax Dialogue, in Marrakech, Morocco, on Tax and Intergovernmental Relations. It provides an overview on recent trends in inter-governmental fiscal relations and points out the uneven developments seen in the decentralisation process.

Spending decentralisation has far outpaced revenue decentralisation, according to the report. While around one-third of government spending and two-thirds of public investment is carried out by the sub-central level, less than 15 percent of tax revenues go to the sub-central level.

These imbalances are generally seen as an obstacle to sub-national accountability and good fiscal performance. The breakdown of clear links between sub-national service provision and its financial consequences for the electorate is commonly seen as a key driver of sub-national fiscal profligacy and soft budget constraints.

Well-functioning intergovernmental frameworks can lead to better economic and fiscal outcomes. Appropriate decentralisation of the public sector, and bringing the state closer to the people, can also help restore trust in public policies and create consensus required for the hard decisions facing most governments, according to the report.

Among other highlights, the report notes the positive association between decentralisation and GDP per capita and discusses the virtues and limits of tax competition between jurisdictions. It also explains how fiscal equalisation - a key social ingredient of fiscal federalism - can help to eliminate differences in regional wealth, although these systems can, in some cases, also reduce the regions’ development efforts.